QGRW Outperforms Growth ETFs (NYSEARCA:QGRW)

The WisdomTree US quality growth fund ETF (NYSEARCA:QGRW) has performed well in the less than one year since its launch. With a return of ~50% year-to-date [YTD], it’s comfortably ahead of the S&P 500 (SP500), which has just posted less than half the returns during this time (see chart below).

The quality in the growth

The passive fund focuses on large-to-mid-cap US stocks, which display both growth and quality characteristics, distinguishing it from just growth funds.

Fund motivation

The motivation to include quality signifiers, as the fund’s literature puts it, is that “..historical returns suggest investing in growth stocks can be a losing game over the long run”. It points to ignoring profitability as a potential risk with investments in “speculative, or junky, growth names”.

On the other hand, focusing only on quality stocks risks missing out on genuine high-growth stocks. This then makes its case for considering a blend of both quality and growth. In fact, it highlights that investing in high-quality growth stocks has historically shown superior stock market returns.

Key metrics

In determining the stocks for its portfolio, it divides them into both growth and quality metrics. Growth is measured in terms of (1) earnings growth forecasts, (2) the trailing five-year EBITDA and (3) trailing five-year sales. Quality is measured with (1) a three-year average return on equity and (2) a three-year average return on assets.

The table below shows that the fund is superior to the S&P 500 on both growth and quality characteristics. But it’s not entirely in line with the Russell 1000 Growth Index either, though they are broadly more alike, as would be expected.

Outperforming growth funds

So far, the growth-quality combination is working for QGRW, when its performance is compared with some of the best performing growth funds this year. Here, it has been compared to heavyweight funds like Vanguard Growth Index Fund ETF Shares (VUG), Schwab US Large-Cap Growth ETF (SCHG) and Vanguard Mega Cap Growth Index Fund ETF Shares (MGK).

While all of them have performed well, to be sure, with over 40% returns for each, QGRW has a lead on price returns. In fact, it’s worth noting that between QGRW and VUG, which lags the most, there’s an almost 9 percentage point difference in price returns.

The others do have some advantages over QGRW, though. The first is their sheer size, which gives assurance of their longevity. VUG, the biggest of the lot, has a massive AUM of USD 170.7 billion. By comparison, QGRW is minuscule with an AUM of USD 101 million. Also, the peer ETFs have a far lower expense ratio of 0.04-0.07% compared to QGRW at 0.28%.

Further, all three also pay a dividend, which QGRW doesn’t. As growth funds, their yields are not their most impressive, ranging between 0.4% and 0.6%. But it does slightly narrow the difference in performance.

Biggest constituents indicate further upside

That all these funds are technology heavy is no surprise, of course. QGRW is marginally more so, with a 47.5% share of the sector in its portfolio. It’s even less surprising that the biggest tech names like Apple (AAPL), Microsoft (MSFT), Alphabet (GOOG), NVIDIA (NVDA) and Amazon (AMZN) are its five biggest holdings with an almost 41% share of the total portfolio.

2023 has been a good year for these stocks (see table below), with NVIDIA as the standout performer, having rebounded with a bang after a steady post-pandemic drop last year. This has spilled into QGRW’s performance as well. The question now is, can QGRW continue to perform well in the next year?

A quick look at its top five holdings does broadly bode well. Consider NVIDIA again. Its forward GAAP price-to-earnings (P/E) ratio at 41.7x is still significantly lower than its five-year average of 61.5x. Amazon is even farther behind its past average, and Alphabet has some upside too.

However, the biggest two constituents, Apple and Microsoft, from just a look at the market multiples, appear to be due for some correction. Still, the implied upside from the remainder is far more than the downside from the biggest.

Weakening consumer discretionary sector

I am, however, more concerned about the consumer discretionary sector, the second-biggest sector holding for QGRW (see chart below). The US market, in particular, is facing a slowdown in consumer spending, evident in the results of multiple companies I’ve covered recently.

But let’s focus on the example of Tesla (TSLA) for a moment, its second-biggest consumer discretionary holding after Amazon, with a 4.5% share in the portfolio. Its revenue growth is slowing down, and its margins are slipping too. This may well be a sign of what’s to come.

In 2023, even with slowing growth, companies did have the advantage of expanding margins as cost inflation softened faster than consumer price inflation. But with CPI inflation having fallen considerably too, the same advantage is unlikely to be present next year. Additionally, demand growth can soften further.

What next?

Essentially, the discussion indicates that there are definite downside risks for next year. These are contained risks, though. The consumer discretionary sector has just a 15% total share in the portfolio, and tech may still perform alright as the balance is tilted more towards the upside. I do think, however, that the kind of returns seen this year, are not a given for 2024.

At the same time, the quality of the fund’s holdings is strong and over time, it can be a good investment. This is further backed by the fact that there’s something to be said about QGRW being a superior investment so far to other growth funds. This, to my mind, is the highlight for a fund with a less than one-year track record. The basis for its motivation is sound, too, with a focus on both growth and quality. I’m going with a Buy on QGRW.